Stock Doctor : Watch the earnings

POST GST, the appointment of new RBI Governor and a good monsoon, there is no trigger that is likely to impact the market significantly. The market may, therefore, witness some profit booking in the short to medium term though the long-term bull market scenario remains intact. The market has not reacted sharply to the announcement of new RBI governor who is by and large expected to follow in the footprints of Raghuram Rajan, keeping inflation in check as the main objective for future policy pronouncements.

In my earlier posts, I have opined that market may not witness any sharp correction due to ample liquidity lying on the sidelines waiting to come to the market in the event of such a correction happening. However, economic activity is unlikely to pick up owing to rising inflation and tepid credit growth. The overall earnings growth of around 10 per cent YoY may not appear bad though the increase in net profit has occurred due to unplanned/unexpected reasons and lower costs in many cases while volume and revenue growth has been generally disappointing.

In view of the tardy acceleration in earnings, the market has started looking expansive. Though mild, the earnings downgrades have started happening for FY17 and experts believe that concrete recovery may be elusive till FY18. As said earlier, Brexit has started showing its impact with Infosys by losing Royal Bank of Scotland. The BSE mid cap PE of more than 32 is way in excess of its 10-year average of 20. This may be a reason to caution retail investors who usually fancy midcaps since such high valuations may not sustain.

Stressed assets of the banking system and overleveraged balance sheets of the corporate sector may continue to weigh on earnings possibilities at the aggregate level. The pricing power of companies generally lacked vigor due to spare capacity and this can be a big trigger for corporate profitability since any expansion in volume/revenue growth will result in increase in profits due to the benefits of operating leverage coming into being.

International developments may also be cause of concern with piling up of dollar debt in the balance sheets of firms in emerging markets, which, as per a Bank of international Settlements (BIS) study, makes them vulnerable to capital outflows. Large outflows can lead to contagion that may adversely affect the Indian market despite India being well placed. China’s credit bubble, falling property prices and massive increase in corporate debt may also have implications for the global economy.

Small investors are advised to exercise caution and not chase stocks though India remains a sweet spot. After all, how many $2 trillion economies are growing at 7 per cent plus rate. The Fed is also unlikely to raise rates anytime soon in view of the volatile global scenario.